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«K C Chakrabarty: The what, why, who and how of financial literacy Address by Dr K C Chakrabarty, Deputy Governor of the Reserve Bank of India, at the ...»

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K C Chakrabarty: The what, why, who and how of financial literacy

Address by Dr K C Chakrabarty, Deputy Governor of the Reserve Bank of India, at the

stakeholders’ workshop on “Financial literacy”, organized jointly by the UNDP, NABARD and

MicroSave, Mumbai, 4 February 2013.

* * *

The assistance provided by Smt. Jaya Mohanty and Smt. Pallavi Chavan in preparation of this address is

gratefully acknowledged.

Dr. Prakash Bakshi, Chairman, NABARD; Ms. Caitlin Wiesen, Country Director, UNDP India;

Mr. Manoj K. Sharma, Director, MicroSave; delegates at the Workshop, ladies and gentlemen. As you all know, financial literacy has emerged as a focus area for policy makers not just in India, but all across the globe, particularly in the aftermath of the global financial crisis. Success in dissemination of financial literacy has been identified as key to meeting the critical objectives of financial inclusion and consequently, financial stability. The workshop is extremely topical as it brings together key stakeholders and brainstorms on steps needed to provide impetus to the financial literacy mission going forward. I congratulate the organizers for today’s initiative and hope that some meaningful and credible strategies emerge from the deliberations.

The United Nations Development Programme (UNDP) has had a significant impact on the social emancipation of people across the globe, ever since its inception in 1966. Over the years, it has focused on Poverty Reduction, Democratic Governance, Crisis Prevention and Recovery; and Environment and Sustainable Development. It is heartening to note that UNDP has partnered with the Government machinery and civil society in India, with a particular focus on seven of the less developed states, to work towards improvement in the quality of lives of the poorest of the poor. Achieving inclusive growth has been one of the predominant objectives of UNDP’s programmes in India and across the world. NABARD, as you all know, was set up with a mandate of facilitating credit flow for promotion and development of agriculture, rural industries and services. It has evolved to occupy a pivotal position in the financial inclusion efforts, particularly in the rural hinterland of the country.

Similarly, MicroSave has also made important contributions in the field of financial inclusion by successfully partnering with diverse stakeholders such as financial institutions, investors, donors, corporate and regulators for providing, what its corporate tagline claims, “Market-led solutions for financial services”. I am happy to note that the three organizations have come together to host today’s seminar and hope that the partnership yields fruitful results for our financial inclusion/ financial literacy initiatives.

I am happy to note that at the behest of UNDP and NABARD, MicroSave has conducted a Financial Literacy Assessment Survey to assess the current status of financial literacy in the UN focused states and to gather relevant inputs from other similar programs operating nationally/ internationally. It is, indeed, very important not only to work hard, but also to have periodic appraisals of the performance, as it helps one to refocus, reorient and undertake mid-course correction, which is so very vital to the achievement of the ultimate objective. I am sure the insight gained from this exercise would provide valuable guidance to UNDP and help them in further streamlining the existing programs and taking it further, both – in terms of its penetration across the targeted states and the impact it has on the financial behavior of the beneficiaries.

In my address today, I shall answer four basic questions about financial literacy:

What is implied by the concept of financial literacy?

• Why is financial literacy necessary?

• Who all need to be made financially literate and in what aspects?

• BIS central bankers’ speeches And finally, how to spread financial literacy?

• What is implied by the concept of Financial Literacy?

Let me begin by answering the first question. Financial literacy is not a new term to all of us present here. While we have heard a number of definitions of financial literacy, I would use the one given by OECD, which defines it as “a combination of financial awareness, knowledge, skills, attitude and behaviours necessary to make sound financial decisions and ultimately achieve individual financial wellbeing.” Financial literacy is expected to impart the wherewithal to make ordinary individuals into informed and questioning users of financial services. It is not just about markets and investing, but also about saving, budgeting, financial planning, basics of banking and most importantly, about being “Financially Smart”.

Financial literacy is a complex concept, and it is important to understand its full import. In fact, as a society, we are yet to fully recognise the need and potential of financial literacy. As I would explain subsequently, financial illiteracy permeates across all levels of society and economic strata. The nature of illiteracy and its manifestations may vary, but it gets reflected in the everyday financial choices that many of us make. The lack of basic knowledge about financial products and services and their risk-return framework is one common instance of financial illiteracy that is widely observed. The greed for higher returns eventually culminates into a crisis involving larger number of retail investors. This basic lesson holds true not just for an individual investing his hard earned savings in financial products, but also for a bank or financial institution that manages public funds and channels them, either as investments or loans. Thus, appreciation of various aspects of financial literacy and how it impacts our lives holds the key to prudent financial planning and welfare maximisation, both- at the individual level and for the society as a whole.

Why is Financial Literacy necessary?

I, now, come to the second question: Why is financial literacy necessary? Together with Financial Inclusion and Consumer Protection, Financial Literacy forms a triad, which is necessary for ensuring financial stability. Not only do the three have a bearing on financial stability, they also have a strong interplay among each other, with each having a vital impact on the other. Thus, financial literacy has significant relevance for financial inclusion and consumer protection. Without financial literacy, we cannot expect to make major headway in either financial inclusion or consumer protection.

Financial inclusion, essentially, involves two elements, one of access and the other of awareness. It is a global issue, and the relative emphasis on the two elements varies from country to country. For developed countries with widespread financial infrastructure, the access to financial products/services is not a matter of concern. It is more of a financial literacy issue in that market players/consumers are required to be educated about the characteristics of the available financial products/services, including their risks and returns. In developing countries like India, however, the access to products itself is lacking. Therefore, here, both the elements, i.e. access and awareness need to be emphasized, with improving access assuming greater priority.

Financial Stability, as a policy objective, refers to the avoidance of financial crises as also to the ability of the financial system to limit, contain, and deal with the emergence of imbalances before they pose a threat to the economic processes. 1 The recent global financial crisis is a glaring example of how lack of financial literacy can impact financial stability. The genesis of the crisis was in the sale of inappropriate mortgage products to sub-prime borrowers, who did not understand the product characteristics. The crisis was also fanned by the creation of

Schinasi, Garry (2004), “Defining Financial Stability”, IMF Working Paper, WP/04/187.

2 BIS central bankers’ speeches sophisticated financial products by seemingly expert market participants, without understanding the underlying risks involved. Ben Bernanke, Chairman, Board of Governors of the Federal Reserve System, remarked “In light of the problems that have arisen in the subprime mortgage market, we are reminded of how critically important it is for individuals to become financially literate at an early age so that they are better prepared to make decisions and navigate an increasingly complex financial marketplace”. 2 As already noted, financial literacy involves imparting knowledge about the risk and return of financial products to the users and providers of these products. It is this knowledge that helps in containing risks and maintaining stability in the financial system. I would like to argue that with knowledge, financial market players are expected to control their avarice for higher returns, keeping in view their inherent risk taking abilities.

Financial literacy is an essential pre-requisite for ensuring consumer protection. The low levels of transparency and the consequent inability of consumers in identifying and understanding the fine-print from a large volume of information leads to an information asymmetry between the financial intermediary and the consumer. In this context, financial education can greatly help the consumers to narrow this information divide. Besides, knowledge about the existence of an effective grievance redress mechanism is essential for gaining the confidence of the unbanked population and overcoming apprehensions they may have about joining, what would appear to be a complex and unfriendly financial marketplace.

For the population group that would have newly entered into the formal financial system through our financial inclusion initiatives, awareness about the consumer protection mechanism is critical as any unsavory experience could result in them being permanently lost to the financial system.

Who needs to be financially literate and in what respect?

This brings me to the third question of who needs to be financially literate. I shall argue here that everyone associated with the financial system needs to be financially literate. This includes all users of financial services, be it the financially excluded resource-poor, the lower and middle income groups or the high net worth individuals; the providers of services; and even the policy makers and the regulators.

For the resource-poor population, which operates at the margin, vulnerability can be acute due to constant financial pressures. Household cash management can be daunting under difficult circumstances, with few resources to fall back upon. Financial literacy efforts, in case of such population groups, essentially, involves educating them about the benefits of being part of the formal financial system and managing short term volatility in incomes and meeting unexpected emergencies without getting trapped in unnecessary debt. To cite one example, a study by NCAER and Max New York Life has shown that in India, around 60 per cent of labourers surveyed stored cash at home, while borrowing from moneylenders at high interest rates; a pattern of saving money that is bound to aggravate financial vulnerability of these labourers. 3 The process of educating these excluded sections would involve addressing deep entrenched behavioural and psychological factors that are major barriers to participating in the financial system.

For the middle and lower-middle income groups that are participating in financial markets as either savers or borrowers or both, i.e. the financially included, financial literacy efforts should aim at enhancing their knowledge about the market and new products/services. For instance, “The Importance of Financial Education and the National Jump$tart Coalition Survey”, Remarks by Ben Bernanke, Chairman, Board of Governors of the Federal Reserve System, at the Jump$tart Coalition for Personal Financial Literacy and Federal Reserve Board joint news conference, on April 9, 2008 at Washington D.C.

“How India Earns, Spends and Saves”, A Max New York Life-NCAER Study, 2008.

BIS central bankers’ speeches there is a large section of our population that has a bank account but refrains from participating in the capital market on account of lack of knowledge. Financial literacy, in such cases, would focus on creating awareness about the way the capital market functions and also about the fact that the equity market provides relatively higher returns as compared to other investments, over a longer time horizon.

Similarly for high net worth individuals, better knowledge about the financial markets, new and innovative products and instruments is important as it helps them in making better use of the available avenues in the financial markets. This knowledge is also useful for fetching greater returns from their investments in the market and to avail credit at relatively cheaper rates. However, whether saving or investing, the basic lesson that “higher return implies higher risks” should not be lost sight of.

While the need for financial literacy for the users of financial products/ services is a well accepted fact, I would like to emphasize that even banks, financial institutions and other market players need to be financially literate and be fully aware of the risk and return framework. Financial literacy for the providers of financial services would involve understanding the risks involved in their businesses and in the products that they offer to their customers. As market players, they need to understand risks inherent in complex financial products and choose wisely while committing funds. For service providers, financial literacy also involves understanding the needs of existing and potential customers and creating products and services suited to those needs.

Finally, I would argue that financial literacy is also relevant for opinion makers and policy makers. Literacy is a must to gauge the needs of the population and financial institutions; to understand the risks inherent in products and markets; and to create a policy environment conducive to attainment of the national goals. Only such an approach would ensure that physical and financial resources are put to their optimum use to generate higher economic growth, while minimizing the financial stability risks.

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